According to Wikipedia, an interest rate swap (IRS) is a derivative in which one party exchanges a stream of interest payments for another party's stream of cash flows. IRSs can be used by hedgers to manage their fixed or floating assets and liabilities. They can also be used by speculators to replicate unfunded bond exposures to profit from changes in interest rates. IRS may come in many different types, including fixed-for-floating rate swaps, floating-for-floating rate swaps, and fixed-for-fixed rate swaps. The present value of a plain vanilla swap can be computed using well-known formulas: the value of the fixed leg is given by the present value of the fixed coupon payments known at the start of the swap, and the value of the floating leg is given by the present value of the floating coupon payment determined at the agreed dates of each payment. Therefore, at the time the IRS is entered into, there is no advantage to either counterparty.
IRSs, however, expose their holders to interest rate risk and credit risk, Wikipedia explains. In a plain vanilla fixed-for-floating swap, the party who pays the floating rate benefits when rates fall. Meanwhile, credit risk on the IRS comes into play if the swap is in the money or not. If one of the parties is in the money, then that party faces credit risk of possible default by another party.
Techniques for measuring risk of a swap are well known in the industry. The DV01 approach uses the dollar value of a one basis point (bps) change in a swap's fixed interest rate to measure risk. DV01 is measured in units of USD per bps. Nevertheless, enhanced techniques and devices to better calculate margin risk associated with a portfolio comprising IRSs is desired.